SEC report offers detailed look at IFRS

As expected, an SEC report released Friday did not contain a
recommendation on whether U.S. public companies should be allowed or
required to adopt IFRS for their financial reporting.

Although the long-awaited, 127-page
report provides a thorough discussion of the issues regarding IFRS
in the United States, the timing of an SEC decision on IFRS remains a
mystery. SEC spokesman John Nester said early this week that the staff
will make a recommendation on IFRS, but there is no timetable for that project.

The report’s voluminous findings focus on areas including:

The progress of the development of IFRS. “The
standards that are issued by the IASB (International Accounting
Standards Board) are generally perceived to be high quality by the
global financial reporting community,” the SEC report says. “However,
there continue to be areas that are underdeveloped (e.g., the
accounting for extractive industries, insurance, and rate-regulated industries).”

Maintenance of IFRS by the IFRS Interpretations Committee (IC)
of the IASB. The mandate of the interpretative body
is to “review, on a timely basis, widespread accounting issues that
have arisen within the context of current IFRSs and to provide
authoritative guidance on those issues. However, the Staff’s outreach
both domestically and internationally indicates that the IFRS IC
should do more to address issues on a timely basis.”

The extent of the IASB’s use of national standard
setters. “In order to develop accounting standards that
could be incorporated in multiple jurisdictions, the IASB needs to
understand the intricacies of a number of distinct domestic reporting
and regulatory systems. This challenge can be difficult in the best of
circumstances,” the report states. While the IASB has procedures for
interacting with national standard setters on individual projects, the
board should consider relying more on national standard setters, the
SEC staff said. “The national standard setters could assist with
individual projects for which they have expertise, perform outreach
for individual projects to the national standard setter’s home country
investors, identify areas in which there is a need to narrow diversity
in practice or issue interpretive guidance, and assist with
post-implementation reviews.”

Application and enforcement. The SEC staff
reviewed financial statements prepared in accordance with IFRS to
assess the consistency in application, which it said is critical to
leveraging the benefits of a single set of global standards. “The
results of the Staff’s review were consistent with its expectations
and confirmed that, while the financial statements reviewed generally
appeared to comply with IFRS, global application of IFRS could be
improved to narrow diversity,” the report says.

Governance of the IFRS Foundation. In
consideration of the needs of U.S. investors and U.S. capital markets,
the SEC staff reported “it may be necessary to put in place mechanisms
specifically to consider and to protect the U.S. capital markets—for
example, maintaining an active FASB to endorse IFRSs.”

Funding of the IFRS Foundation (the IASB’s parent
organization). The SEC worries the foundation continues
to rely heavily on large public accounting firms. “While the IFRS
Foundation indicates that IFRS is used on some basis in more than 100
countries around the world, currently funding is provided to the IFRS
Foundation by businesses, not-for-profits, and governments in fewer
than 30 countries,” the SEC report states.

Many companies indicated that the costs of full IFRS adoption could
be among the most significant costs ever required from an accounting
perspective, according to the report. It says companies questioned
whether the benefits would justify such a full-scale transition.

The SEC invited comments to its report. Use the SEC’s internet
comment form or send an e-mail to rule-comments@sec.gov.

The AICPA has long supported the goal of a single set of
high-quality, global financial reporting standards to be used by
public companies in the preparation of transparent and comparable
financial reports throughout the world, and it believes that IFRS is
best positioned to become those global standards.

“We applaud the SEC staff for its robust efforts to review IFRS, and
we urge the commissioners to consider the staff report with expediency
because the world’s capital markets know no borders. The participants
in those markets need high-quality, transparent, and comparable
financial information to enable them to make sound investment
decisions,” Barry C. Melancon, CPA, CGMA, AICPA president and CEO,
said in a statement.

“We also urge the commissioners to allow U.S. public companies the
option to adopt IFRS,” said Melancon. An adoption option would provide
a level of consistency in the treatment of U.S. companies and foreign
private issuers that report under IFRS that does not exist today, and
would facilitate the comparison of U.S. companies that elect IFRS with
their non-U.S. competitors that use IFRS.

IASB Trustees Chair Michel Prada said in a statement
that the report reiterates challenges that other nations have overcome
when completing their own transition to IFRS. Prada expressed
disappointment that the report did not include a clear action plan for
IFRS for the SEC.

“We are at a pivotal moment for our organization,” he said in a
statement. “The IASB has started working on a new agenda. The era of
convergence is coming to an end. We are revamping our institutional
infrastructure to provide for a more inclusive approach to
international standard setting. This is the right timing to come on
board and participate in shaping the future of global accounting.”

Implementation intricacies

A vast majority of stakeholders who commented on IFRS incorporation
preferred an endorsement process that would involve FASB, according to
the report.

Although the SEC could mandate that publicly traded U.S. companies
use IFRS as issued by the IASB, the report said that would affect
other regulators and may require additional federal and state legislation.

FASB could have more or less influence in setting the new standards:
It could either write each IASB standard into U.S. GAAP as is and
without delay, or it could consider IASB standards during its own
standard-setting process.

A scenario the SEC staff identified between the two extremes would
allow FASB to endorse new or newly modified IFRS standards for
incorporation into U.S. GAAP. The “vast majority” could be endorsed
without change, but FASB would have the authority to add or modify the
IFRS standards subject to a protocol that considers the public
interest and protection of investors. In the rare case that IFRS
standards had gaps, FASB would be allowed to fill them.

Under the endorsement process, FASB could act as a strong U.S. voice
in the interests of U.S. investors, according to the report. To
prevent too much divergence from the IASB standards in the U.S., the
SEC staff suggested the IASB “take U.S. perspectives into greater
consideration during the standard-drafting process—resulting in
standards that meet the needs of U.S. constituents without the need
for modification during the endorsement process.”

Former FASB Chairman Robert Herz said the document was comprehensive
and thoughtful, and predicted that the SEC ultimately will head toward
an endorsement approach. He said the contours of that approach would
be important. He said questions remain about how the process would
work when FASB decided to reject or recommend changes to an IFRS standard.

“What kind of reporting would the FASB have to do in that regard and
how would all that work?” Herz asked. “If additional implementation
and interpretation is necessary in this country, how would that work?
For example, would the FASB just undertake that or would there be some
protocol to refer that to the IASB, and see whether they can deal with it?”

Terri Polley, president and CEO of the Financial Accounting
Foundation, FASB’s parent organization, commended the report.

“The FAF and the FASB look forward to examining the report in
greater detail and will continue to closely monitor the Commission’s
next steps,” Polley said in a statement. “The FAF and the FASB remain
committed to creating greater comparability in global accounting
standards.”

Other challenges

Investors have generally supported the idea of a single set of
high-quality international standards, but the report says their
worries include the lack of investor participation on the IASB and
IFRS Foundation, and the potential for political interference in
standard setting.

Evaluating the auditability and enforceability of IFRS has been one
of the most difficult parts of the work plan, the report says. The
staff had little direct insight into audits of financial statements
prepared in accordance with IFRS.

Federal and state tax effects of adopting IFRS are covered briefly
in the report. If current federal and state tax law is not amended to
reflect IFRS, the report says, companies would be required to track a
significantly increased number of book-tax differences. Some companies
would also end up paying more tax because IFRS does not permit the use
of the LIFO method for inventories, and the Internal Revenue Code
requires that a company use the same method of inventory accounting
for financial and tax reporting purposes.

A change to IFRS might also require companies to request permission
from the IRS to change accounting method and might affect computation
of U.S. earnings and profits for federal tax purposes. Transfer
pricing policies may also be affected.

The report identified two areas of state taxation that could be
affected by the adoption of IFRS: (1) apportionment of income, if the
adoption of IFRS changed underlying apportionment factors; and (2)
taxes based on a company’s net worth or equity, if the adoption of
IFRS affected either of those.

Who’s ready?

The level of preparedness for a transition to IFRS varies widely,
the report says. Many large public accounting firms with an
international presence have experts already on staff or have IFRS
training programs in place.

The majority of firms, however, would need training or would need to
hire IFRS experts as consultants or fulltime employees, both costly
propositions. The report says most companies’ employees “currently
have little or no knowledge of IFRS requirements or developments and
are only focused on U.S. GAAP.”

Preparers of financial statements—including about 10,000 issuers
that file reports with the SEC—would be significantly affected by a
transition to IFRS, the report said.

Issuers generally supported a single set of high-quality, globally
accepted accounting standards, the report said. But many issuers
expressed a concern about how much change the financial reporting
system could absorb. More issuers preferred a managed transition
through which FASB would incorporate IFRS into U.S. GAAP. Small
issuers, particularly those who don’t have global operations,
expressed more concern about the transition than bigger issuers who
compete globally.

“If you’re a large [business] this [move to IFRS] would produce
enormous cost savings,” said Cal State Fullerton accounting professor
Vivek Mande. But U.S. domestic companies or businesses with limited
operations abroad may not see the advantage, he said.

The SEC staff was clear about how difficult the transition could be
for some companies. While some standards would be easy to convert,
others would require issuers to overhaul accounting systems, controls,
and procedures.

To adopt the converged standard for revenue recognition, for
example, an issuer will likely have to review existing contracts;
evaluate outstanding customer transactions; revise corporate
accounting policies; establish new or modify existing internal
controls; and determine whether the accounting processes responsible
for the original accounting before adoption of the new accounting
standard must be retained in order to comply with contractual
covenants or regulatory reporting, the report said.

That would require staff training and internal testing, not to
mention the costs of additional external audit procedures required to
evaluate and test the new processes, the report said.

And the transition could impact industries differently. Some
commenters expressed concerns about the incorporation of more
principles-based accounting on the Federal Acquisition Regulation
(FAR) system and government contractors, for instance. The FAR’s cost
accounting standards (CAS) incorporate U.S. GAAP. But it is unclear
whether, and, if so, how the CAS would be transitioned to IFRS—whether
the CAS would be modified to incorporate IFRS, or whether affected
issuers would need to maintain dual accounting records.

The report said that regardless of the outcome of the SEC’s decision
on whether to incorporate IFRS, the staff expects that the SEC and
others in the United States will remain involved with the development
and application of IFRS.

David Schmid, CPA, U.S. IFRS leader for PricewaterhouseCoopers, said
he believes the SEC wants the United States to remain relevant in
international accounting. He said that with a U.S. presidential
election coming up in November, any decisions on IFRS probably won’t
occur until next year.

“Hopefully there is a sense of realism out there that this is a long
process,” Schmid said, but the release of the long-awaited report is a
key step in that process.

Latest News

FEATURED VIDEOS

Most Read

Features

MANAGEMENT ACCOUNTING

A good leader recognizes that part of the job is developing the next generation of leaders. Veronica McCann, CGMA, a former division CFO at Commerzbank in Singapore, shares tips on developing future finance leaders.

A weekly snapshot of global accounting with news from the Journal of Accountancy and other leading accounting publications. It includes summaries of what matters to you, written by expert editors to save you time and keep you informed and prepared.